How Does A Business Valuation Work?
Why get a business valuation?
There are four main reasons you may want to get a valuation for your business;
To assist you in buying or selling a business
Understanding the process of valuation can help to:
– Select the best time to buy or purchase the business and increase the chance of finding potential buyers
– Finalise the purchase more quickly
– Improve the real or recognised worth of the firm
To improve equity capital
A valuation can assist you in agreeing on a price for the newly issued shares.
To create a single market for shares
This allows employees to buy shares in the company at a good price.
To encourage and motivate management
This will allow you to improve the performance of management with incentives and measurement, focus your team on essential issues, and show the areas of the firm that require improvement.
Factors affecting a business valuation
Three basic criteria can affect the valuation of your business. They are;
The valuation circumstances
– Ongoing businesses can be valued in a few different ways
– Any forced sales will reduce the business’s worth. This could be an owner-manager who is retiring because of ill health and who may have to take the first offer that’s given.
– If you’re winding up the firm, its worth will become the sum of its achievable assets, fewer liabilities.
How real the assets are
– A firm that owns machinery or property has real assets
– Lots of companies such as small businesses don’t have any tangible assets except office tools and equipment. The main thing that will be valued is future profits.
How strong the firm is
– Lots of businesses suffer losses in the first few years
– A new firm might have a negative net asset value, but it might be very valuable in terms of upcoming profits
Multiple of profits
This method involves adjusting your business’s profits to put back any benefits that the current shareholders or owners are receiving. This could be operating personal vehicles through the firm to pension contributions. You’ll also add on any one-off costs that aren’t likely to happen for a new owner.
Asset valuation takes into account your liabilities and assets, which are the accounting figures you recorded in your books. This formula is quite straightforward – the value of your business equals assets minus liabilities.
Discounted cash flow
This valuation method concentrates on your business’s future performance instead of past data. If your cash flow is predictable and consistent, your company is more likely to have a higher value estimate.
The discounted cash flow method estimates how much cash your firm is estimated to create into perpetuity. It will then be discounted into current dollars (known as NPV – net present value), whilst considering the financial risk indicated by your industry or business.
The price/earnings ratio or P/E is a widely used method for measuring a firm’s worth. A price/earnings ratio is performed by dividing the market price for each share by the firm’s earnings per share.
Valuation “rules of thumb”
To pave the way for an accurate and fair valuation of your firm, consider these general rules of thumb:
- Know why the valuation is being done
- Understand the business that’s being valued
- Use the correct metrics for the valuation
- Get a professional opinion
Are intangible elements of a business taken into account?
Yes, intangible assets such as good customer relationships, knowledge, people, and intellectual property might be a huge part of your firm’s overall worth. For example, a strong relationship with a key supplier or customer could be critical.
This is because if a firm has a UK license for products that are predicted to be a success, the firm’s worth will increase.